The landscape for sustainability reporting has changed in recent years due to a number of developments. One of the most widely used set of guidelines for sustainability reporting, published by the Global Reporting Initiative (GRI), was revised and released in October The GRI guidelines form the basis of a sustainability disclosure framework and contain principles and guidance plus standard disclosures for all types of organisations. The principles define the content of sustainability reports, the quality of the information, and the report boundary. The standard disclosures include the organisation's sustainability strategy and profile, management approach, and performance indicators. The guidelines are similar in purpose to the conceptual
used to guide financial reporting.
Companies adopting the GRI guidelines can register their sustainability reports with the GRI, and by March 2009 nearly reports for 2008 were registered. The growth in sustainability reporting is confirmed by a recent survey by KPMG on corporate economic, environmental, and social performance The survey finds that over 90 per cent of Global Fortune 250 companies publish 'sustainability' or 'corporate responsibility' reports. KPMG also reported that 70 per cent of the reporting companies worldwide use the GRI guidelines, possibly due to the perceived credibility of the standards and the advantage gained from using a consistent set of standards which make the reports more comparable across companies. In addition to the impact of their own operations, companies are also reporting data on sustainability impacts arising in the company's supply chain.
The growth in reporting on environmental issues is also driven by the emergence of markets in permits to emit greenhouse gases or in credits earned by not emitting them. Companies affected by these markets are required to account for their greenhouse gas emissions and report under the prescribed rules to the relevant regulatory
The development of mandatory emissions permit trading, in particular the establishment of the European Union Emissions Trading Scheme (EU ETS) in January 2005, has also
contributed to a closer association between financial reporting and environmental, or sustainability, reporting. This is due to the need to consider how to account for emission rights, or permits, and the liabilities that accrue as the emissions are made.
The EU ETS was not the first carbon market established, but it is the largest, with an annual trade in permits of billion in 2006 and billion in In the period prior to the introduction of the EU ETS the International Financial Reporting Interpretations Committee (IFRIC), a subsidiary body of the IASB, released a document prescribing the acceptable accounting treatment for emission IFRIC 3 Emission Rights required companies to treat all allowances as intangible assets. This meant that they had to recognise the fair value of any free allowances immediately as income, while the costs of the corresponding emissions would be recognised only gradually as they Cook describes the response to the document as a 'public outcry' and it was withdrawn in June attributes the controversy to the fear that IFRIC 3's recommendations would produce increased earnings volatility as the income and expenditures were mismatched in argues that companies prefer to treat emission rights as financial and adopt hedge accounting under IAS 39. This would allow the company to then offset allowances and corresponding emissions, keeping 'carbon' off the balance
A report by and the International Emissions Trading
Association (IETA) shows little support for the IFRIC 3 method of accounting, as well as substantial variation in accounting for rights." Their survey shows that six main methods of accounting for emissions rights are currently in use in European companies, with fifteen different approaches to classifying the EU ETS on the companies' balance The most common approach is to recognise the granted allowances at nil value, with the obligation recognised at the carrying value of allowances already
with the balance at the prevailing market price.
and IETA conclude that in addition to the lack of clarity and comparability of financial statements produced by companies with emissions rights, the absence of authority on this issue has caused both frustration and a waste of resources for these companies." In addition, because their survey did not address the needs and views of external stakeholders it is not known what impact the variability in accounting for emission rights has on their ability to rely on this information for decision making. In response to the problems in accounting for emission that have arisen in Europe and the growing likelihood of other emissions trading schemes being established, the IASB has recently announced it will re-activate its project on Emissions Trading Schemes and a standard is expected in
Climate change and sustainability issues are also affecting traditional financial reporting through decisions about asset impairments and risk disclosures. Climate change can pose a physical threat to asset values; for example, low-lying coastal land could be at increased risk of flooding. Also, the value of operational assets is adversely affected by falling demand for the products they produce. For example, a in demand from high-energy appliances towards low-energy appliances because of changing attitudes or increasing electricity costs would affect the value of the assets used to make high-energy appliances.
Further, insurance companies in the United States must now disclose to the insurance regulator how climate change is likely to affect their businesses, and by implication, their The regulations require insurance companies to make 'climate risk reports' that address the risks of higher claims from their clients due to extreme weather events. Insurers should also disclose their vulnerability to falling profits from their investments in companies that would be adversely affected by caps on carbon emissions utility'
companies). A l t h o u g h t h e climate r i s k reports n o w required o f insurance companies are n o t p a r t o f accounting regulations, t h e y are evidence o f a t r e n d towards investors a n d o t h e r stakeholders d e m a n d i n g better i n f o r m a t i o n o n h o w climate
l i k e l y t o affect companies' There are also p o t e n t i a l obligations for disclosure o f operational, m a r k e t a n d credit risks o f t h e c a r b o n m a r k e t u n d e r IFRS 7 Financial instruments:
The following extract is from PricewaterhouseCoopers and International Emissions Trading Association Trouble-entry accounting
-
Revisited*.Accounting approaches for the EU ETS -
view
The withdrawal of 3 means that under the hierarchy for selecting accounting policies i n 8 'Accounting policies, changes i n accounting estimates and errors' other accounting models are acceptable (as long as they are consistent w i t h underlying IFRS).
The main accounting approaches w h i c h consider to be acceptable are surnmarised i n table.
Initial recognition - Granted allowances
Initial recognition - Purchased allowances
Treatment of deferred Government grant amortised Subsequent treatment of
allowances
on a systematic and rational basis over compliance
Recognition of liability Recognise liability when
Full market value approach 3)
Recognise when able to exercise control; corresponding entry to government grant at market value at date of grant. Recognise when able to exercise control, at cost. Allowances are
subsequently held at cost or re-valued amount, subject to review for impairment.
incurred.
Allowances are Allowances are subsequently
Cost of settlement approach
held at cost or held at cost or re-valued
Alternative Approach 1
Recognise when able to exercise control; corresponding entry to government grant, at market value at date of grant. Recognise when able to exercise control, at cost.
amount, subject to amount, subject to review for review for impairment. impairment.
Alternative Approach 2
Recognise when able to exercise control; recognise at cost, which for granted allowances is a nominal amount nil). Recognise when able to exercise control, at cost.
Government grant amortised Not applicable. on a systematic and rational
basis over compliance
incurred. incurred.
Liability is re-measured fully Re-measure liability at each Re-measure liability at each based on the market value period end. For allowances period end. For allowances of allowances at each period held,-re-measure to carrying on hand, at the carrying end, whether the allowances amount of those allowances amount of those allowances are on hand or would be market value at date of (nil or cost) on a or purchased from the market. recognition if cost model i s weighted average basis.
used; market value at date A liability relating to any of revaluation if revaluation excess emission would be re- model i s used) on either a measured at the market value
or weighted average at the period end. basis. A liability relating to
any excess would be re-measured at the market value at the period end.
Note: this summary does not deal with the accounting for emissions allowance b y
example
To illustrate the impact on the financial statements of these accounting approaches consider the following scenario:
Companies A, B and C all have financial year ends of 31 December 2006 Each receives 150 granted allowances at the start of the year
The market price at grant date was per allowance
Each company requires 200 allowances to cover its obligation for the 2006 compliance year to be settled in February 2007
The market price at 31 December 2006 was f 2 5 per allowance Accounting policies adopted
Company A has adopted the Alternative Approach 1 Company B has adopted the Alternative Approach 2
Company C has adopted the 'full market value' approach 3)
Figures in Income statement
Release of deferred income Emissions cost Net result Balance sheet Intangible assets Liability Net assets Current year result Revaluation reserve Shareholders funds Alternative approach 1 Company A -1 250 -1250 (iii) -1 250 -1 250 3000 -5000 (iv) Alternative approach 2 Company B -2000 3000 -5000 -2000 -2000 3 Company C Notes:
150 allowances received at market value at grant date per allowance (1 50 * £20 = £3,000)
liability based on allowances held measured at carrying amount, and liability related to excess emission market value at period end * + (50 = £4,2501
50 shortfall in obligation measured at market value at period end £25 per allowance 200 obligation measured at market value at period end £25 per allowance
The financial results show that companies A and B have identical net results. However, company A effectively has a grossed up balance sheet in comparison with Company B.
Company C has applied the 3 approach and has a very different net result and balance sheet.
It is important to note that each entity, making the same level of emissions and holding the same number of allowances w i l l ultimately be required to make up the same shortfall in allowances. In the example each company w i l l have to finance the shortfall of allowances, which if the price of allowances remained constant would cost each company 1,250. For company C, the decision to value the entire obligation at the prevailing market price of allowances means that there is a mismatch in the timing of recognition, with the following year recognising a credit to the income statement of f750 as the liability is settled. This highlights the volatility in earnings that can arise with the use of this method.
Further differences in results could arise considering when the shortfall is recognised. One approach could be to recognise the expected shortfall, and associated cost and liability, over the financial year. Others, meanwhile, recognise the cost and liability only when the emissions obligation exceeds the assets held. Hence, for two identical companies
receiving the same number of allowances and making the same level of emissions, the liability at the year-end would be identical, the position at the half year or at quarter would of course be very different between the two approaches.
There i s an additional consideration for entities using Alternatives 1 and 2, as measurement of the obligation for which allowances are held will depend on whether carrying amount of allowances is allocated to the obligation on a or on a weighted average basis. This i s a particular issue where the balance sheet date is not at the end of the compliance period (for example, an interim balance sheet date, or a financial year- end which is not the same as the compliance period end).
Entities using the method should measure the obligation at the carrying amount per unit of emissions, up to the number of allowances (if any) held at the balance sheet date, and at the expected cost (the market price at the balance sheet date) per unit for the shortfall (if any) at the balance sheet date.
Entities using the weighted average method should measure the obligation using the weighted average cost per unit of emission expected to be incurred for the compliance period as a whole. To do this, the determines the expected total emissions for the compliance period and compares this with the number of allowance units granted by the government purchased and still held by the entity for that compliance period, to determine the expected shortfall (if any) in allowances held for the compliance period. The weighted average cost per unit of emission for the compliance period is the carrying amount of the allowances held may be nil for those granted for nil consideration) plus the cost of meeting the expected shortfall (using the market price at the balance sheet date), divided by the expected total number of units of emission for the compliance period. In other words:
Carrying amount of allowances held
+
Cost ofmeeting expected shortfall Weighted average cost per unit of Expected total units of emission for the
compliance period
Organisations that choose to actively manage their emissions asset and liability face further accounting decisions. For example, consider an organisation that reports quarterly and sells all of its 2007 allowances in March 2007. Some would claim that the income from the sale should be recognised immediately as a credit to the income statement. This would of course be partially offset by a debit to the income statement to reflect emissions in the year to date not covered by any allowances held. However there is a mismatch between recognising the value of months allowances against the cost of three months of emissions. Alternatively, some would claim that the credit to the income statement be deferred and released over the remainder of the compliance year.
Differences in accounting treatment concerning recognition of emissions obligations and allowances could therefore have a significant impact on financial reporting, particularly where the organisation reports quarterly or half-yearly results or has a financial year which is not co-terminus with the compliance
Source: and the International Emissions Trading Association 2007, pp. 27-8, www.ieta.org.
Questions
Recalculate each company's financial statements using the following assumptions: (a) Each company requires 250 allowances to cover its obligation for the compliance year (b) The market price at 31 December 2006 was £40 per allowance.
2. Recalculate each company's financial statements using the following assumptions: (a) Each company requires 1 00 allowances to cover its obligation for the year
The market price at 31 December 2006 was f40 per allowance.
3. Comment on the differences between your solutions and the above example.